Leading theory of Dodd-Frank rule challenges takes a body blow

By Alison Frankel
December 14, 2012

If there were a Playboy magazine for sexy federal laws, the Administrative Procedure Act would not be in it. I seriously doubt that any “Law and Order” episode or plotline of “The Good Wife” has been built around the 1946 statute that governs how federal agencies may establish new regulations, and yet judicial interpretations of the APA are what determine if new regulations live or die. Consider, for instance, the Dodd-Frank financial reforms. Congress got all the credit or blame (depending on your perspective) for passing the umbrella law in 2010, but its actual implementation depends on the rule makers at the Securities and Exchange Commission and Commodity Futures Trading Commission, enacting regulations in accordance with the APA.

Business groups including the U.S. Chamber of Commerce have sued to overturn five new Dodd-Frank rules the SEC and CFTC approved, each time claiming that the agencies did not follow proper procedures. Specifically, the challenges — both to two CFTC rules expanding regulation of derivatives trading and to the SEC’s proxy access, extraction issuer and conflicts mineral rules — have asserted that the SEC and CFTC did not engage in sufficient analysis of the costs and benefits of the new regulations.

That theory received a powerful endorsement from the District of Columbia Court of Appeals in July 2011, when a three-judge appellate panel struck down the SEC’s proxy access rule, which would have required public corporations to provide investors with information about shareholder-nominated board candidates. In a harsh assessment of the agency’s rule-making process, the District of Columbia Circuit found that the SEC “inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters,” the opinion said. The appeals court concluded that the SEC had been arbitrary and capricious in enacting the proxy access rule, violating the APA.

The proxy access rule challenge, led by the Business Roundtable and the U.S. Chamber, was the first to be filed and decided, so it’s no surprise that subsequent suits seeking to overturn Dodd-Frank rules also argued that the agencies were arbitrary and capricious in passing the regulations — even though the agencies said they’d learned from the Business Roundtable ruling and revised their rule-making processes. In September, U.S. District Judge Robert Wilkins of Washington didn’t reach the question of the agency’s compliance with the APA, since he found that the CFTC violated the Commodity Exchange Act by failing to determine whether limits on derivatives tied to physical commodities were necessary before it imposed them. From the tenor of his ruling, though, Wilkins had doubts as well about the process by which the CFTC drafted and approved the new regulation, lending more credibility to such challenges. (Last month, the CFTC announced that it would appeal Wilkins’s ruling.)

But if business groups thought the APA was a silver bullet to kill off Dodd-Frank regulations, a ruling this week by U.S. District Judge Beryl Howell of Washington provides some bullet-proof armor to federal agencies. Howell was considering a challenge by the Investment Company Institute and the U.S. Chamber to the CFTC’s rule requiring registration of mutual funds that engage in derivatives trading. The business groups made the familiar arguments that the agency had not adequately considered the costs of the new rule or the benefits of requiring mutual funds already regulated by the SEC to submit to another regulator. Howell resoundingly rejected the theory, concluding that under the U.S. Supreme Court’s 2011 ruling in Judulang v. Holder, the “mere fact” that a regulation carries costs and burdens does not make that rule arbitrary and capricious.

Howell went even further, calling for deference to the CFTC and to Congress, which specified its intentions in Dodd-Frank. “While the CFTC must consider and evaluate the costs of its rules pursuant to its obligations under the (Commodities Exchange Act), as Judulang makes clear, the CFTC is not required to promulgate only rules that have low or no costs,” she wrote. “Rather, the agency is simply required to show that they ‘considered’ and ‘evaluated’ the costs of the rule. Therefore, the suggestion that the court should find an agency’s actions arbitrary and capricious because regulations carry costs is unavailing. Furthermore, the plaintiffs’ emphasis on the costs and burdens of the final rule obscures the overall purposes and benefits of the rule. Where the final rule is ‘moored’ to the ‘purposes and concerns’ of Dodd-Frank, and well within the agency’s discretion, and where the agency determines that the costs of the final rule are outweighed by its benefits, this court finds no reason for finding that the agency acted in a manner that was arbitrary and capricious.”

The judge found that Dodd-Frank and the CFTC had demonstrated the benefit of a transparent derivatives market by linking the financial crisis to opacity. That benefit couldn’t be quantified, but the business groups’ claims that the agency hadn’t offered adequate reasons to o verturn its own 2003 deregulation of the derivatives market was a “false assertion,” according to Howell.

“The court will not disturb the agency’s ruling as arbitrary and capricious for finalizing a prophylactic rule to prevent problems before they arise in the agency’s blind spots,” she wrote. “The CFTC not only provided justifications for the rule-making, but also explained the significance of the potential benefits of the rule-making.” Howell specifically distinguished the derivatives case from the District of Columbia Circuit’s ruling on the SEC’s proxy access rule, citing the CFTC’s careful consideration of industry arguments about over-regulation.

With two more Dodd-Frank rule challenges in their early stages, Howell’s reasoning on the deference owed to rule makers shifts the momentum away from the business groups and their go-to lawyer, agency scourgeEugene Scalia of Gibson, Dunn & Crutcher. As the Litigation Daily noted in a report Thursday, Scalia had a 5-and-0 record going into Howell’s ruling. Now he’s 5-and-1, and the loss is emphatic.

I left a message with Scalia and with the Chamber of Commerce, asking about the impact of Howell’s decision on future Dodd-Frank challenges. I didn’t get a response.

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